Cooperative or Controlling? the Effects of CEO-Board Relations and the Content of Interlocks on the Formation of Joint Ventures

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The board interlock network has been viewed as an ideal arena in which to develop and test the embeddedness perspective on interorganizational relations. The board of directors is a unique formal mechanism linking top managers of large corporations; it provides an opportunity for leaders to exchange information, observe the leadership practices and style of their peers, and witness firsthand the consequences of those practices. Thus, from this perspective, board ties to other firms should have a strong influence over corporate policy and strategy decisions. The empirical literature on board interlocks has extended research on the diffusion of innovations by specifying the social networks through which a variety of policies and practices are spread across firms (e.g., Mizruchi, 1992; Haunschild, 1993; Palmer, Jennings, and Zhou, 1993; Westphal and Zajac, 1997).

While interlock research has advanced our understanding of the consequences of interlocks for firms, significant concerns have also been raised that reflect more general concerns about the application of network theory to interorganizational relations (Mizruchi, 1996). Several authors have expressed concern about the consistency and magnitude of network effects (Stinchcombe, 1990; Fligstein, 1995). Weak or inconsistent findings may result from two limitations common to most prior studies. First, prior interlock research has not adequately specified the content of network ties (Hirsch, 1982; Pettigrew, 1992; Mizruchi, 1996: 288). Content here implies a specification of the nature of the relationship and behavioral processes underlying a connection between two actors. Although recent research in the governance literature suggests that relationships between top managers on corporate boards may be characterized by independence and distrust in some cases (Westphal, 1999), in the interlock literature all ties are generally treated as equally positive connections that facilitate social cohesion and the exchange of information between firms. This ignores heterogeneity that may exist among interlocks in the extent to which they channel information and engender trusting relations between board members.

Another concern with interlock research is its primary focus on the effect of direct ties or relational embeddedness on firm behavior to the exclusion of more distant network ties or structural embeddedness (Granovetter, 1992). While there is ample evidence in network research that both relational and structural embeddedness can influence behavior (e.g., Burt, 1987; Gulati and Gargiulo, 1999), this has had limited application in interlocks research. Studies in the larger network literature have shown that indirect network ties between actors can strongly condition the effects of direct ties between them (Gulati, 1995b). Moreover, recent research also suggests that indirect network ties can amplify differences in the magnitude of the effect of direct ties, such that distrust between actors is exacerbated in the presence of indirect ties between them (Burt and Knez, 1995). Thus, it may be possible to uncover stronger interlock effects by modeling variation in the content of direct ties and examining how such ties are conditioned by the larger social structure.

The present study examines the influence of heterogeneous social processes that underlie interlock ties, and the moderating effects of indirect network ties, on the creation of strategic alliances between firms. Some ties may promote the creation of a new alliance, while others could actually reduce its likelihood, depending on the behavioral content of the tie. As a result, there may be both bright and dark sides to embeddedness in interorganizational relationships. Although recent studies have focused on how the network of prior alliances provides valuable information to potential partners about each other's reliability, capabilities, and needs (Kogut, Shan, and Walker, 1992; Gulati, 1995b; Powell, Koput, and Smith-Doerr, 1996), this literature has not considered the role of alternative networks such as board interlocks in guiding the formation of new alliances or in strategic cooperation between firms. In this paper, we examine the role of board interlocks, focusing on a subset of alliances known as joint ventures, which entail the creation of a separate legal entity in which the parent firms take equity, and use the term alliance to refer specifically to joint ventures. Such alliances typically entail a considerable outlay of resources and create enduring and irreversible commitments between partners, which can make the influence of the board interlock network on their formation even more important. Such a network can be an important source of information for top managers about the reliability and capabilities of potential venture partners.

CONTENT OF INTERLOCK TIES AND EFFECTS ON ALLIANCES

Empirical studies examining the consequences of interlocking directorates for the diffusion of innovations and the likelihood of strategic change have typically viewed interlock ties in broad terms as a mechanism for resolving uncertainty for top management decision makers (Galaskiewicz, 1985a). In discussing how interlock ties may facilitate the diffusion of an innovation, scholars have emphasized the value of direct communication between managers and directors in reducing ambiguity about the implications of adoption. From this perspective, information from fellow corporate leaders is particularly influential because it comes from a trusted source (Davis, 1991; Haunschild, 1993). Research on the consequences of interlocking directorates would also suggest that interlock ties could help resolve uncertainty for top management decision makers about the implications of forming strategic alliances with another firm. Moreover, the question here relates not only to the adoption of strategic alliances in general, but also to the choice of a specific partner. While prior research has typically described interlocks as conduits of information about administrative innovations, it is reasonable to expect that board members also communicate information about their respective parent organizations. The social embeddedness created by interlock ties should help resolve uncertainty for top managers about the motives and management capabilities of other organizations as potential alliance partners.

Despite their explosive growth, strategic alliances are associated with a variety of risks and pitfalls that result in considerable uncertainty about the decision to enter such ties. This uncertainty stems from two main sources (Gulati, 1995a, 1995b). First, organizations have difficulty in obtaining information about the competencies and needs of potential partners. Such information is often confidential and may not be revealed outside a close relationship, but organizations must understand the needs and capabilities of potential partners if both organizations are to derive benefits from the alliance. The second source of uncertainty that affects strategic alliances stems from the paucity of information about the reliability of the potential partners, whose behavior is a key factor in the success of an alliance. Organizations entering alliances face considerable moral hazard concerns because of the unpredictability of the behavior of partners and the likely costs to an organization from opportunistic behavior by a partner, if it occurs (Kogut, 1989; Doz, Hamel, and Prahalad, 1989; Gulati, Khanna, and Nohria, 1994; Khanna, Gulati, and Nohria, 1998). A partner organization may either free ride by limiting its contributions to an alliance or may simply behave opportunistically, taking advantage of the close relationship to use resources or information in ways that may damage the partner's interests.

Recent research builds on Granovetter's notion of embeddedness (1985) and suggests that organizations address the potential hazards associated with building alliances by relying on information provided through existing interorganizational networks (Gulati, 1998). While the focus of this research has been on the role of the network of prior alliances (e.g., Gulati and Gargiulo, 1999), board interlocks may also channel information between firms and thus serve as a catalyst for the creation of new alliances between firms. Beyond allowing top managers to form relationships with managers of prospective alliance partners, board ties may also enable directors to acquire firsthand knowledge about another firm's capabilities, activities, and plans through their communications with top management and their involvement in the decision-making process. Top managers can identify and pursue alliances by jointly discovering opportunities for collaboration in ongoing discussions. Networks can also provide information in a timely manner, which can be important when a firm seeking attractive alliance partners must approach them at the right juncture and preempt their seeking alliances elsewhere. This suggests an initial, baseline hypothesis on the effect of interlock ties on alliance formation:

Hypothesis 1: An interlock tie between two firms will increase the likelihood of subsequent alliance formation between them.

The discussion thus far has assumed that interlock ties indicate positive social contact between top managers and outside directors of the focal firm. A similar rationale has been used in much prior research on board interlocks and the diffusion of organizational innovations. As interlock researchers have generally recognized, however, there is considerable variation in the nature of management-board relationships, though the consequences of this heterogeneity have yet to be systematically examined (Herman, 1981; Johnson, Hoskisson, and Hitt, 1993; Mizruchi, 1996). The form of management-board relationships can range from a positive and relatively cohesive relationship between top managers and outside directors to a negative and independent one, with very different consequences for the likelihood of venture formation.

Independent Board Control and Alliances

According to agency perspectives, while top managers are responsible for ongoing decision management, the board of directors is responsible for decision control, which involves monitoring and evaluating management decision making and performance (Fama and Jensen, 1983). In effect, the board is viewed as an efficient control device that can help align management decision making with shareholders' interests (Beatty and Zajac, 1994). For instance, to the extent that managers' personal preferences regarding executive compensation, corporate diversification, or other strategy and policy issues conflict with the interests of shareholders, boards can intervene to ensure that shareholders' interests are protected (Hermalin and Weisbach, 1988; Hill and Snell, 1988). Moreover, from this perspective, outside directors in particular are critical to the board's ability to exercise control, because as non-employee directors they are formally independent from management and thus better able to evaluate management decisions and actions objectively on behalf of shareholders' interests.

In prior years, this agency model of the relationship between the chief executive officer (CEO) and the board could be dismissed as an anomaly. Organization theorists have typically suggested that while outside directors are in a position to exercise independent control over management, various behavioral factors effectively limit the social independence of outsiders, impairing their ability or willingness to exert control. For instance, given evidence that CEOs traditionally dictate the selection of new directors, several authors have suggested that CEOs can appoint personal friends or other individuals with whom they have preexisting social ties (e.g., Finkelstein and Hambrick, 1988; Wade, O'Reilly, and Chandratat, 1990; Cannella and Lubatkin, 1993). Such ties are thought to inhibit the board's willingness to contradict management's preferences on behalf of shareholders. Moreover, organization theorists have long maintained that generalized norms of support among managerial elites enforce a passive role for outside directors in strategic decision making (e.g., Herman, 1981; Whisler, 1984). From this perspective, boards have little potential to serve as independent agents of control and, supporting the assumption of interlock theorists, management-board ties are characterized by social cohesion.

The recent literature on boards of directors, however, has provided some evidence that widespread norms about the role of corporate boards may be changing. Useem (1993) and Westphal and Zajac (1997) have documented the spread of changes in board structure, composition, and executive compensation that appear to indicate increased board control over management among large corporations over the past fifteen years. This trend may have originated in response to external criticism from institutional investors and other stakeholders and the threat of lawsuits over perceived negligence in protecting shareholders' interests (Kesner and Johnson, 1990; Davis and Thompson, 1994). External constituents have demanded evidence that boards are willing to challenge management's decisions on their behalf. For instance, boards have been told to expand the search for new directors beyond the CEO's close circle of personal friends and to alter board structure and processes in ways that diminish the CEO's direct control over board meetings (Kaplan and Harrison, 1993; Daily, 1996). In effect, boards have been pressured to adopt a role characterized by more independent monitoring and control over management. Nevertheless, while there has been a general move toward more assertive boards that assert greater control over CEOs, there remains considerable variance across boards in the extent to which they have adopted a controlling orientation.

The consequences for alliance formation. There are several possible consequences of independent board control on the prospects of alliance formation between the focal firm and manager-directors' home companies. On one level, a CEO-board relationship characterized by monitoring and control simply entails lower cohesion between the CEO and the board, or the absence of a strong tie, but it may go further than that. Independent board control over management may actually produce a negative relationship between the CEO and the board characterized by a lack of mutual understanding and distrust. When benevolence and support toward the CEO is replaced with independent control over the CEO, leaders of the firm can become effectively divided into separate groups: decision managers (i.e., the CEO and other top managers) and decision controllers (i.e., outside directors) (Fama and Jensen, 1983), where they were previously common members of a mutually supportive, inner circle of elites (Useem, 1982). The literature on intergroup relations has provided consistent evidence, in both laboratory and field settings, that dividing a single group of individuals into two or more separate groups has a variety of negative effects on relations between members of the different groups (Miller and Brewer, 1996). Empirical studies have demonstrated that when individuals are divided into separate groups, attitudes about the out-group members become significantly more negative (Gaertner et al., 1989; Messick and Mackie, 1989). In particular, group categorization has been shown to foster distrust toward out-group members while also creating the perception of intergroup conflict (Kramer, 1996; Miller and Brewer, 1996; Labianca, Brass, and Gray, 1998).

Out-group categorization, which in the case of interlocks occurs when CEOs view outside directors as controllers rather than supporters or fellow managers, can promote distrust both with respect to the capabilities of the other party (task-based trust) and the risk that they might limit their contributions to the relationship (relational trust) (Creed and Miles, 1996), thus prompting negative evaluations of the perceived capability and personal reliability of the other party. This outgroup bias occurs even when the basis for group categorization is arbitrary or minimal (Brewer, 1979). Moreover, Kramer (1994, 1996: 224) and others (Fenigstein and Vanable, 1992) have found evidence that when individuals are subjected to "evaluative scrutiny" or control by out-group members, "a pattern of exaggerated mistrust" may develop.

Applying research on intergroup relations to the CEO-board context, we expect that when outside directors assert themselves as an independent group of controllers accountable to shareholders rather than management, distrust can arise between top managers and outside directors. Whereas outside directors on passive and supportive boards are effectively insiders with regard to their orientation toward management, on controlling boards such directors adopt the perspective of an independent outsider. As a result, the perception of a division between insiders and outsiders can reinforce "a generalized sense of distrust" across groups and lead to "escalating cycles of distrust" when out-group members are exercising control (Sitkin and Stickel, 1996: 199). A behavioral manifestation of distrust is "reduced cooperative efforts of all kinds" and enhanced competition for resources and status between groups (Brewer and Kramer, 1985; Gaertner et al., 1989; Creed and Miles, 1996: 27). Thus, intergroup bias would lead each party of the management-board relationship to view members of the other group as less trustworthy in both professional and personal terms, reducing interest in various forms of cooperation. …

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